November 30, 2011
Consumer Discretionary
Activision Blizzard Inc.
Ticker: _ATVI____ Recommendation: Hold
Current Price: $11.75 Implied Price: $13.95
Investment Thesis
Key Statistics
52 Week Price Range $10.40 - $14.40 Activision Blizzard is in a strong position to continue profiting
from in place franchises such as Call of Duty and World of
50-Day Moving Average $12.92 Warcraft
Estimated Beta 0.72 Increase in company digital sales should outpace competitors
leading to a reduction in Cost of Goods Sold and higher margins
Dividend Yield 1.4%
The industry performance is picking up in coming years due to
Market Capitalization $13.44 Billion increase in technology and gamer demographics
3-Year Revenue CAGR 13.69% New company focus on proven franchises will increase company
efficiency and continued success in both console and online
Trading Statistics gaming
Diluted Shares Outstanding 1.18 Billion
Average Volume (3-Month) 10.13 million
Activision Blizzard Inc. (5- Year)
Institutional Ownership 33.90%
$20.00 80000000
Insider Ownership 61.11%
$18.00 70000000
EV/EBITDA 8.41x $16.00
60000000
Margins and Ratios $14.00
$12.00 50000000
Gross Margin 59%
$10.00 40000000
EBITDA Margin 24% $8.00 30000000
Net Margin 15% $6.00
20000000
Debt to Enterprise Value NA $4.00
$2.00 10000000
Leverage Ratio NA
$0.00 0
Oct-06 Oct-07 Oct-08 Oct-09 Oct-10
Volume Price 50-Day Avg 200-Day Avg
Covering Analysts: Ryan Swift
Email: Ryans@uoregon.edu
1 University of Oregon Investment Group
University of Oregon Investment Group November 30, 2011
Business Overview
Activision Blizzard, Inc. (ATVI) is a developer, publisher, and
distributor of online, personal computer, console, and handheld interactive
entertainment. It was formed July 9, 2008, when Activision, creator of the
popular Call of Duty and Guitar Hero video games merged with Blizzard
Entertainment, creator of such games as World of Warcraft, Starcraft and
Diablo. Together the two represented the largest share at 9.2% of the video
game publishing industry. Activision Blizzard is a controlled company due to
Vivendi owning over 50% of its shares. There are three main operating
segments of Activision Blizzard.
Activision Publishing (57%of revenue)
Activision publishing, headquartered in Santa Monica California develops,
publishes, markets and sells interactive entertainment products through retail
channels or digital downloads. It's portfolio of game franchises include Call of
Duty, Guitar Hero, Cabala's Hunting, Marvels Spider-Man and X-Men , James
Bond, Transformers, and Skylanders Spyros Adventure. Activision Publishing is
focusing its investments on proven intellectual properties to deep, high quality
content for online multiplayer gaming experiences. This segment of the
companies often licenses games form third party developers in search of the
next big thing. The trend of this market is to move to online content that is going
to push margins higher. This is being partly combated by the industry trend to
increase the expenditure on large box office style marketing campaigns for large
releases such as Call of Duty Modern Warfare 3. The Call of Duty franchise
continues to set first day and total franchise sales.
Blizzard Entertainment (34% of Revenue)
Head quartered in Irvine California Blizzard entertainment was established in
1994. The companies mission statement is simple "Dedicated to the most epic
entertainment experiences...ever". They have achieved this by developing and
publishing such games as World of Warcraft, Starcraft and Diablo. These tittles
continue to set records with the last World of Warcraft expansion selling 3.3
million copies in the first 24 hours. This segment of Activision Blizzard lowers
the companies Beta by providing a constant income stream from the monthly
subscription to play World of Warcraft. On top of monthly subscriptions,
players will pay for the introduction of expansion packages. Starcraft and
Diablo do not have a monthly fee but the actual game costs are around twice as
much as World of Warcraft. Blizzard Entertainment is in charge of managing
battlenet, the first online gaming service that allows gamers to join multiplayer
games, chat and download free and paid material. A subscription to Battlenet is
free. Blizzard Entertainment has also come out with related trading card games,
board games, apparel and books.
UOIG 2
University of Oregon Investment Group November 30, 2011
Activision Blizzard Distribution (9% of Revenue)
The distribution segment provides logistics, warehousing, and sales distribution
services in Europe to its own publishing operations, third party publisher of
software and third party manufacturers of interactive entertainment hardware.
Strategic Positioning
Activision Blizzard is strategically positioned with what they call "leading
market positions across all categories" of the video game industry. The
company's main strategic advantage is the success of its existing franchises.
With Call of Duty being the most successful gaming franchise of all time
Activision Blizzard is well positioned to continue profiting from and growing
the franchise through increase user engagement as the trend in the industry is to
focus on major titles. Activision's World of Warcraft franchise requires a
monthly subscription that creates a constant stream of revenue. This allows the
company to focus else ware to find "the next big thing" for continued success.
The new release of Call of Duty Elite online gaming environment is in place to
create a constant stream of cash flows. The company's new focus on proven
material will improve efficiency and continued success. The company is mildly
vertically integrated with its own distribution throughout Europe and several in
house developers.
Business Growth Strategies
Activision Blizzard Inc, focuses on four main areas to continue growth.
Continue to Improve Profitability,
Effectively manage risk and increase operating leverage and efficiency by
focusing on core properties, proven franchises, proven genres, and their ability
to leverage the growth of online and digital revenue opportunities.
Create Shareholder Value,
Continue to provide value to their shareholders through stock repurchases and
cash dividends by growing operating margin, maintaining a strong balance sheet
and generating strong cash flows
Grow Through Continued Strategic Acquisitions and
Alliances,
Expand the company resources and portfolio of intellectual property licenses
through acquisitions, strategic relationships, and licensing agreements. A major
focus is on acquisitions of or investments in interactive experience software
development firms as success in the industry is heavily dependent of the ability
to create new successful titles.
Focus on Delivery of Digital Content and Online Services,
Activision Blizzard is continually shifting towards digital delivery of content to
their gamers which can be seen through their World of Warcraft and Call of
Duty online communities. This will help lower their cost of sales and drive
margins. Also, being able to provide online product innovations such as
additional online content and increased social connectivity will help build
lasting relationships with its gamers.
UOIG 3
University of Oregon Investment Group November 30, 2011
Activision blizzard has chosen to focus the majority of its time and finances on
established and proven content such as the World of Warcraft and Call of Duty
franchises while making small acquisitions to try and find "the next big thing".
The most recent being Skylanders Spyro's Adventure.
Industry
Overview
Activision Blizzard's main line of business is in the Video Game Software
Publishing industry. It is the largest player in the industry at 9.2% followed
closely by Nintendo and Electronic Arts Inc. It is a 28.8 billion dollar industry
that experienced 5.5% annual growth in the last five years and is expected to
grow at 7.8% annually in the next five years. The industry is still in a growth
stage as it is fairly new and still reaching new demographics. It can be expected
that industry growth will outpace the US economy in the near future. Capital
intensity in the industry is low as it is labor intensive industry. On average for
every dollar spent on capital there is $9.23 spent on labor. Capital Expenditures
are generally on office space and server computers. The capital expenditures are
expected to rise looking forward with the need for larger servers for online
gaming. Regulation in the industry is low with firms subscribing to voluntary
ratings performed by the Entertainment Software Ratings Board but in 2011 the
supreme court ruled that the government does not have the right to "restrict the
ideas to which children may be exposed". This means that gamers of any age
can buy a game with any rating. This industry is highly competitive with
companies in direct competition for a highly skilled work force, aggressive
marketing and franchising tactics, and obtaining the rights to publish newly
developed games. Barriers to entry are high in this industry due to a high level
of patents and strong established relationships with developers.
Drivers.
The two key drivers for this industry is per capita disposable income. As
individuals disposable income increases they have more money to spend on
expensive items for leisure time, such as video games and video game consoles.
The other main driver for the industry is the time spent on leisure activities. As
Activision Blizzard's games directly compete for individuals leisure time, the
more leisure time that is available, the more time can be spent playing video
games. This driver is expected to decrease looking forward as individuals return
to jobs they are qualified for. Additional drivers include the availability of a
highly skilled work force which is driven by the number of college students with
a lag time of about two year. This drivers is expected to slow looking forward
which will lead to higher expenditure on employee salaries. The amount of
broadband internet connections has a direct effect on the industry as the trend is
to play hit tittles on online multiplayer modes.
Trends
There are several new trends changing the way video game are being played.
Blockbuster releases
Recently video game releases have been shifting to large blockbuster releases
with more capital being spent on marketing. This is in response to the shift in
consumer preferences to spend their gaming time on a smaller number of large
UOIG 4
University of Oregon Investment Group November 30, 2011
titles such as Call of Duty, Halo, and World of Warcraft. This trend is also
reducing the number of smaller titles that are being introduced in the industry.
Online Game-play
An increase in demand for online game play is changing the video game
industry in several ways. The largest change is that it is changing the way that
content is being delivered. Games and expansion packages can be purchased
online which reduces material costs for business's in the industry and drives up
margins. This is also leading to a change in some business's revenue models to a
subscription based model. This can be seen by the introduction of the new Call
of Duty Elite. While there is a free version at your disposal it is Activision's
hope that you will opt for the upgraded version on a subscription bases.
These new opportunities are being partially offset by the need for increased
security expenditures. As interactive online communities grow so does the threat
of a cyber attack. In 2011 Sony's Playstation network experienced an attack
where millions of individuals personal information was stolen and the system
was down for around 23 days.
New Customers
The introduction of the Nintendo Wii widened the customer base of video
games. With the Wii came the introduction of fitness and mental sharpening
games such as "Zumba Fitness" and "Big Brain Academy". This is broadening
the target market for video games to include women, younger children and
adults of age 45years+. Women are now 40% of video game players.
Cross Platform Play,
The industry is expected to shift towards the cross-platform gaming. This means
that Individuals playing online on a Microsoft XBOX system can play versus
someone using a Sony Playstation. Activision Blizzard recently released the first
version of cross platform gaming with Skylanders, Spyro's Adventures.
Competition
Video game software publishing is a highly competitive industry in many
aspects.
Talented workforce.
Successful firms in this industry are ones that are able to create hit titles so the
necessity for a talented workforce is high. Many software development firms
locate themselves in close proximity to top universities.
Brand Names,
Customer loyalty is high so firms need to continually create value for their
gamers in the form of new and improved gaming content. The inability to do so
can ruin a brand name and have severe consequences for the firm.
Adapt to changes in technology,
Gaming technology is rapidly changing and the ability of a firm to adapt to the
changes is crucial. First mover advantage in this area can be large. This can be
seen through the Nintendo Wii. Although the Sony Playstation and Microsoft
Xbox have recently been able to take advantage of similar technology, Nintendo
received a large first mover advantage. Looking forward it will be important for
firms to take advantage of 3D technologies and cross platform gaming.
UOIG 5
University of Oregon Investment Group November 30, 2011
Intellectual Property,
This is extremely important in order to protect your ideas from competing firms.
Since many firms have patents on their products it creates a large barrier to entry
for startups.
Relationships,
Many firms in the industry have in house developers but most firms rely on third
party developers to create the games to publish. The establishment of these
relationships is a key to continued success. This creates another large barrier to
entry for new publishers as developers have strong relationships already in
existence.
Consoles,
Software publishers that also create consoles have a competitive advantage
because they can dual market their products. It also helps in the establishment of
a brand name.
Management and Employee Relations
CEO - Robert A Kotick
Director and CEO of Activision since February 1991, Mr. Kotick become CEO
of Activision Blizzard after the merger with Blizzard in 2008. Mr. Kotick owns
3,828,221 shares of Activision Blizzard with a market value of $44,981,597.
Vice Chairman - Michael J. Griffith
Former president and CEO of Activision publishing Mr. Griffith was appointed
to vice Chairmen in March 2010. Before joining Activision Mr. Griffith held
several executive positions with Procter and Gamble from 1981 to 2005. He has
a B.A. degree from Albion college and an M.B.A from the University of
Michigan. Mr. Griffith owns 57,108 with a market value of $671,019.
CEO Activision Publishing - Eric Hirshberg
Appointed to CEO in September 2010, Mr. Hirshberg was hired from Deutsch
LA, an American marketing firm where he served many executive positions. Mr.
Hirshberg received his B.F.A degree from University of California at Los
Angeles. Mr. Hirshberg owns 62,564 share with a market value of $735,127.
Management Guidance
Historically, management beats EPS guidance. In order for the stock price to go
up it takes a significant amount of surprise above guidance. This also means that
if they miss guidance by a small amount that it can have a large negative impact
on the stock price. Last quarter, even though ATVI beat guidance negative news
about their World of Warcraft subscription base lead to a significant drop in
share price. Management should continue to give beatable guidance.
UOIG 6
University of Oregon Investment Group November 30, 2011
Portfolio History
Svigals
The Svigals portfolio bought 225 shares on 11/10/2008 at a cost basis of $12.58
per share and again purchased 91 share on 8/17/2010 at a cost basis of $10.99 a
share. The first purchase has realized a negative 5.5% and the second purchase
is up 8% since its purchase.
Tall Firs
The Tall Firs portfolio bought 1500 shares of ATVI on 11/14/2008 at a cost
basis of $12.20 per share. We still own all 1500 shares and it is currently up
.33% since we bought it. It accounts for about 2.73% of the portfolio.
Recent News
One-day sales tally sets new video game record
"Activision Blizzard's "Call of Duty: Modern Warfare 3" racked up more than
$400 million in sales on its first day in stores in North America and the United
Kingdom, setting a video game industry record. Activision's biggest holiday title
sold 6.5 million units in a single day after going on sale early this week,
surpassing last year's record of 5.6 million "
~ Reuters
Consensus was around 6 million units on the first day. The extra half million in
sales was not a large enough surprise to Wallstreet as ATVI was down around
2% on a day when the market was up.
Blizzard: World of Warcraft Subscriptions Dropping
"Activision also noted that its other gaming juggernaut, World of Warcraft,
could finally be approaching its denouement. Blizzard president and co-founder
Mike Morhaime revealed World of Warcraft has lost 2 million subscribers in the
past year"
~ Gamespy
The majority of the loses are coming from the east. This should be combated by
the release of the new World of Warcraft Mists of Pandaria which has been
suggested to be targeted at the eastern market. The losses related to the reduction
in current subscriptions have been priced in.
Catalysts
Upside
Increase in disposable income
Success of new releases
Good news about European debt crises
Successful holiday season
Above consensus growth in disposable income
above expected margin growth
Downside
Reduction in World of Warcraft subscriptions
Bad news about European debt crises
Poor Holiday season
Below consensus growth in disposable income
UOIG 7
University of Oregon Investment Group November 30, 2011
Comparable Analysis
A relative valuation was performed in order to price Activision Blizzards shares
based on its peers. Finding comparable companies was difficult for Activision
Blizzard as many of its competitors are privately owned, foreign or have
experienced poor performance leading to low EBIT and EBITDA margins.
The multiples used were EV/Gross Profit and EV/ EBITDA. EV/Gross profit
was used to because the ability to keep costs down is going to be a driver for
success looking forward. EV/EBITDA was used as this is the best indicator of a
company's cash flows. A 50% weighting was given to both EV/Gross Profit and
EV/EBITDA
Electronic Arts, ERTS 40% weighting
Incorporated in 1982, Electronic Arts is Activision Blizzards largest competitor.
In the early 2000's due to several acquisitions of developers, EA was one of the
world's largest third party publishers. One of EA's main strategic advantages it's
near monopoly on the sports game industry. Through licensing contracts, EA is
the only company allowed to use NFL, ESPN and NCAA football licenses.
Additionally it has non exclusive agreements with the NHL, NBA, and
NASCAR. Outside of sports games, some of EA's notable game franchises
include The Sims, Skate, Battlefield, Rack Band, Army of Two and many more.
ERTS was chosen because it is Activision Blizzards biggest competitor, it has a
similar product offering, similar capital structure and risk. Having a like
business model means that ERTS is going to go about generating cash flows in a
similar manner. This company was given a 40% weighting because of its total
similarity in business and its similarity in margins.
Intuit 40% weighting
"Intuit, incorporated in March 1984, is a provider of business and financial
management solutions for small and medium-sized businesses, consumers,
accounting professionals and financial institutions. The Company’s products and
services, including QuickBooks, Quicken and TurboTax, simplify small
business management and payroll processing, personal finance, tax preparation
and filing and personal finance."~Reuters
Intuit was used as a comparable due to its similar risk, size and line of business.
Since both companies create computer software they are subject to many of the
same risks and competitive forces. Intuit as given a 40% weighting due to its
similarity in size, risk and margins.
Microsoft 20% weighting
"Microsoft Corporation, incorporated in 1981, is engaged in developing,
licensing and supporting a range of software products and services. Microsofts
product lines include operating systems for personal computers (PCs), servers,
phones, and other intelligent devices; server applications for distributed
computing environments; productivity applications; business solution
UOIG 8
University of Oregon Investment Group November 30, 2011
applications; desktop and server management tools; software development tools;
video games, and online advertising." ~Reuters
Microsoft's exposure to the video game industry include the Xbox 360 gaming
and entertainment console, Kinect for Xbox 360, Xbox 360 accessories, and
Microsoft PC hardware products
Microsoft was used as a comparable because it also operates in the computer
software industry. Microsoft has similar risk to Activision Blizzard and also has
some exposure to the video game industry with its x-box 360. Microsoft
received only a 20% weighting due to its differences in business operations and
overall size.
Discounted Cash Flow Analysis
The Discounted Cash flow analysis is an attempt to value the share price of a
company based on the intrinsic value. This is done by discounting the expected
future free cash flows back to the present value using a discount rate that
represents what an investor would expect to earn on an equally risky asset else
ware.
Beta
To find the company beta four betas were equally weighted. A three year and
five year weekly beta against the S&P 500 were run. The three and five year
ranges were chosen because of the acquisition of Blizzard by Activision
approximately three years ago. It is appropriate to have a blend of the beta of
Activision before and after the acquisition of Blizzard due to the addition of
World of Warcraft and its constant stream of cash flows to the Activision
portfolio. For the other two betas a five and three year weekly Vasicek beta was
computed. The Vasicek beta adjusts the beta to take into consideration the
industry beta and the standard errors. The companies used to compute the
industry beta were Nintendo, Konami Corp, Electronic Arts, Take-Two
Interactive Software, Intuit and Microsoft.
Revenue model
To predict future revenues, the companies goods and services were broken down
into five categories. The segments were forecasted by reviewing growth in
previous years and adjusting based on expected industry outlook, the present
position of each segment and its alignment with industry trends and then
trending the growth rate towards 3%.
Massive Multiplayer Online Role Playing Game- MMORPG (28% of revenue)
This is comprised of sales related to Blizzards World of Warcraft franchise.
Growth is expected to slow looking forward. World of Warcraft lost
approximately 800,000 subscribers in the east last quarter. They are expected to
gain them back with the release of the new expansion Mists of Pandaria.
PC and Other (7% of revenue)
This includes Blizzard's Diablo and Starcraft. There are no major changes for
this segment looking forward.
Console (52% of revenue)
UOIG 9
University of Oregon Investment Group November 30, 2011
All games and services related to game play on Xbox 360, Playstation 3,
Nintendo Wii and other consoles that may arrive in the future. This is expected
to remain Activision Blizzards largest segment.
Handheld (4% of revenue)
Publishing for handheld devices such as the Apple i-phone, i-pad and other
emerging mobile devices. With the rapid increase in smart phone technology
this segment is expected to see rapid growth in the near future.
Distribution (9% of revenue)
This segment is related to the warehousing, logistics and distribution of products
in Europe and is expected to decrease as a % of revenue due to the increase in
digital sales.
Expenses
COGS were broken down into four segments; Software royalties and
amortization, Product costs, MMORPG and intellectual properties. They were
projected out based on percent of revenue taking into consideration industry
trends and management guidance. Product costs are expected to be reduced
permanently with the industry trend of increasing digital sales. Other expenses
including Product Development, Sales and Marketing, General and
Administrative, impairment of intangible assets and restructuring were
forecasted in the same way. Special considerations were taken for several line
items. Sales and marketing is estimated to rise over time with the transition to
Blockbuster style releases. General and Administrative expenses are expected to
decrease as they have been high in recent years due to the acquisition of
Blizzard. Product development is expected to decrease in the near future due to
the businesses focus on core titles but it is likely to rise in the future due to the
need for a new hit as many of Activision Blizzards titles are aging.
Working Capital
The majority of working capital was projected on percent of revenue. Accounts
receivable was forecasted using days Inventory Outstanding A/R. Line items
were normalized and projected forward based on guidance and industry trends.
Acquisitions
Activision Blizzards growth strategy is reliant on acquisitions. Looking forward
acquisitions is projected to grow as a percent of revenue in the form of several
small acquisitions. Activision Blizzard is not expected to make any acquisitions
as large as that of Blizzard.
Capital Expenditures
Capital Expenditures are expected to increase looking forward as the need for
larger servers for online interactive gaming environments.
Depreciation and amortization
Depreciation and amortization was projected using a straight line depreciation
schedule. 100% of capital expenditures and 60% of acquisitions were
depreciated.
UOIG 10
University of Oregon Investment Group November 30, 2011
Recommendation
Activision Blizzard's is not being properly valued by the market. Although the
relative valuation says that it is overpriced this could be due to poor comparable
companies or an undervaluation of the sector as a whole. This is why I chose to
weight the comparables analysis at 30% and the Discounted Cash Flow
valuation at 70%. According to the Discounted Cash Flow valuation Activision
Blizzard is underpriced by 30%. This is due to the market not recognizing its
curing positions that are in line with industry trends and possibly an
undervaluation of the sector as a whole. This is why I am recommending a hold
for Activision Blizzards for both the Tall Firs Svigals portfolios.
UOIG 11
University of Oregon Investment Group November 30, 2011
Appendix 1 – Comparables Analysis
Comparables Analysis ATVI ERTS TTWO INTU MSFT
Activision Interactive
($ in millions) Blizzard Inc Electronic Arts Software, Inc Intuit Inc Microsoft
Stock Characteristics Max Min Weight Avg. Median 40.00% 0.00% 40.00% 20.00%
Current Price $49.27 $0.00 $32.90 $20.83 $11.88 $20.83 $13.27 $49.27 $24.30
50 Day Moving Average 52.10 12.85 35.36 24.78 12.85 23.04 14.30 52.10 26.51
200 Day Moving Average 49.84 11.88 34.08 24.13 11.88 22.48 14.36 49.84 25.78
Beta 1.12 0.72 0.41 1.07 0.72 1.02 1.12
Size
Short-Term Debt 500.00 0.00 200.00 0.00 0.00 0.00 0.00 500.00 0.00
Long-Term Debt 11,927.00 0.00 2,585.00 0.00 0.00 0.00 0.00 499.00 11,927.00
Cash and Cash Equivalent 9,610.00 0.00 2,582.80 722.00 2,812.00 930.00 280.36 722.00 9,610.00
Non-Controlling Interest 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Preferred Stock 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Diluted Basic Shares 8,504.18 0.00 1,959.44 315.09 1,180.87 331.43 97.11 315.09 8,504.18
Market Capitalization 206,651.63 0.00 50,006.77 6,576.31 14,028.73 6,576.31 1,252.97 15,114.81 206,651.63
Enterprise Value 210,218.63 0.00 50,670.57 6,175.31 11,216.73 6,175.31 972.61 15,391.81 210,218.63
Profitability Margins
Gross Margin 82.58% 37.93% 72.39% 68.50% 59% 60% 38% 83% 77%
EBIT Margin 41.40% 1.98% 21.86% 16.97% 20% 4% 2% 30% 41%
EBITDA Margin 45.33% 3.42% 27.00% 22.42% 24% 8% 3% 36% 45%
Net Margin 33.01% (4.00%) 11.59% 6.29% 15% -4% -4% 16% 33%
Credit Metrics
Interest Expense $60.00 ($899.00) ($158.35) $7.58 $0.00 ($6.38) $21.53 $60.00 ($899.00)
Debt/EV 6.49% 0.00% 3.73% 2.84% 0.00% 0.00% 0.00% 6.49% 5.67%
Leverage Ratio 0.71 0.00 0.36 0.18 0.00 0.00 0.00 0.71 0.37
Interest Coverage Ratio 2335.00% (4998.43%) (1782.66%) (1717.17%) 0 -49.98433093 1.520821723 23.35 -35.86429366
Operating Results
Revenue $71,120.00 $957.93 $17,273.60 $3,812.00 $5,520.00 $3,773.00 $957.93 $3,851.00 $71,120.00
Gross Profit 54,905.00 363.31 13,155.40 2,718.00 3,261.00 2,256.00 363.31 3,180.00 54,905.00
EBIT 29,444.00 18.99 6,410.40 652.00 1,117.00 144.00 18.99 1,160.00 29,444.00
EBITDA 32,242.00 32.75 7,136.40 860.00 1,333.00 319.00 32.75 1,401.00 32,242.00
Net Income 23,478.00 (151.00) 4,888.80 298.36 804.00 (151.00) (37.28) 634.00 23,478.00
Valuation
EV/Revenue 4.00x 1.02x 2.84x 2.30x 2.03 1.64 1.02 4.00 2.96
EV/Gross Profit 4.84x 2.68x 3.80x 3.28x 3.44 2.74 2.68 4.84 3.83
EV/EBIT 51.22x 7.14x 23.89x 28.08x 10.04 42.88 51.22 13.27 7.14
EV/EBITDA 29.70x 6.52x 13.44x 15.17x 8.41 19.36 29.70 10.99 6.52
EV/Net Income 24.28x (40.90x) (4.86x) (8.57x) 13.95 (40.90) (26.09) 24.28 8.95
UOIG 12
University of Oregon Investment Group November 30, 2011
Appendix 2 – Discounted Cash Flows Analysis
Discounted Cash Flow Analysis
($ in millions) 2008A 2009A 2010A 2011 E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E 2019 E 2020 E 2021 E
Total Revenue 3026.00 4279.00 4447.00 5320.09 $5,826.53 $6,271.20 $6,691.24 $7,092.29 $7,472.39 $7,816.40 $8,116.09 $8,365.94 $8,608.93 $8,850.81
% YoY Growth 41.41% 3.93% 19.63% 9.52% 7.63% 6.70% 5.99% 5.36% 4.60% 3.83% 3.08% 2.90% 2.81%
Cost of Goods Sold 1839.00 2307.00 2126.00 1623.33 2,354.40 2,395.15 2,477.33 2,547.55 2,690.81 2,822.50 2,930.72 3,020.94 3,108.68 3,196.03
% Revenue 60.77% 53.91% 47.81% 30.51% 40.41% 38.19% 37.02% 35.92% 36.01% 36.11% 36.11% 36.11% 36.11% 36.11%
Gross Profit $1,187.00 $1,972.00 $2,321.00 $3,696.76 $3,472.13 $3,876.05 $4,213.91 $4,544.74 $4,781.58 $4,993.90 $5,185.37 $5,345.00 $5,500.24 $5,654.78
Gross Margin 39.23% 46.09% 52.19% 69.49% 59.59% 61.81% 62.98% 64.08% 63.99% 63.89% 63.89% 63.89% 63.89% 63.89%
Selling General and Administrative Expense 735.00 939.00 884.00 1010.82 1153.78 1217.56 1309.64 1419.40 1506.95 1595.92 1679.97 1750.82 1823.51 1897.28
% Revenue 24.29% 21.94% 19.88% 19.00% 19.80% 19.42% 19.57% 20.01% 20.17% 20.42% 20.70% 20.93% 21.18% 21.44%
Product Development 592.00 627.00 642.00 691.61 699.18 721.19 869.86 922.00 971.41 1016.13 1055.09 1087.57 1119.16 1150.61
% Revenue 19.56% 14.65% 14.44% 13.00% 12.00% 11.50% 13.00% 13.00% 13.00% 13.00% 13.00% 13.00% 13.00% 13.00%
Impairment 0.00 409.00 326.00 299.50 328.02 353.05 376.70 399.27 420.67 440.04 456.91 470.98 484.66 498.27
% Revenue 0.00% 9.56% 7.33% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63%
Restructuring 93.00 23.00 0.00 26.60 14.57 15.68 16.73 17.73 18.68 19.54 20.29 20.91 21.52 22.13
% Revenue 3.07% .54% 0.00% .50% .25% .25% .25% .25% .25% .25% .25% .25% .25% .25%
Earnings Before Interest & Taxes ($233.00) ($26.00) $469.00 $1,668.23 $1,276.58 $1,568.57 $1,640.98 $1,786.34 $1,863.86 $1,922.27 $1,973.11 $2,014.72 $2,051.40 $2,086.50
% Revenue -7.70% -0.61% 10.55% 31.36% 21.91% 25.01% 24.52% 25.19% 24.94% 24.59% 24.31% 24.08% 23.83% 23.57%
Investment and other net income 46.00 18.00 23.00
% Revenue 1.52% .42% .52%
Earnings Before Taxes (187.00) (8.00) 492.00 1,668.23 1,276.58 1,568.57 1,640.98 1,786.34 1,863.86 1,922.27 1,973.11 2,014.72 2,051.40 2,086.50
% Revenue (6.18%) (.19%) 11.06% 31.36% 21.91% 25.01% 24.52% 25.19% 24.94% 24.59% 24.31% 24.08% 23.83% 23.57%
Less Taxes (Benefits) -80.00 -121.00 74.00 415.31 446.80 549.00 574.34 625.22 652.35 672.79 690.59 705.15 717.99 730.27
Tax Rate 34.33% 465.38% 15.78% 24.90% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00%
Net Income ($107.00) $113.00 $418.00 1245.92 $829.78 $1,019.57 $1,066.64 $1,161.12 $1,211.51 $1,249.47 $1,282.52 $1,309.57 $1,333.41 $1,356.22
Net Margin -3.54% 2.64% 9.40% 23.42% 14.24% 16.26% 15.94% 16.37% 16.21% 15.99% 15.80% 15.65% 15.49% 15.32%
Add Back: Depreciation and Amortization 385.00 347.00 198.00 119.27 108.63 120.69 131.70 142.52 153.19 163.65 173.52 182.61 190.74 198.87
Add Back: Interest Expense*(1-Tax Rate) 30.21 (65.77) 19.37 5.60
Operating Cash Flow 308.21 394.23 635.37 1354.10 938.41 1140.26 1198.33 1303.64 1364.71 1413.12 1456.04 1492.18 1524.15 1555.09
% Revenue 10.19% 9.21% 14.29% 25.45% 16.11% 18.18% 17.91% 18.38% 18.26% 18.08% 17.94% 17.84% 17.70% 17.57%
Current Assets 5,259.00 5,329.00 5,385.00 6692.04 7,869.55 8,478.25 9,066.19 9,616.68 10,154.49 10,621.98 11,029.23 11,368.76 11,698.97 12,027.67
% Revenue 173.79% 124.54% 121.09% 125.79% 135.06% 135.19% 135.49% 135.59% 135.89% 135.89% 135.89% 135.89% 135.89% 135.89%
Current Liabilities 2,084.00 2,507.00 2,907.00 3386.59 4,082.21 4,393.76 4,688.05 4,969.04 5,235.35 5,476.37 5,686.34 5,861.39 6,031.63 6,201.10
% Revenue 68.87% 58.59% 65.37% 63.66% 70.06% 70.06% 70.06% 70.06% 70.06% 70.06% 70.06% 70.06% 70.06% 70.06%
Net Working Capital $3,175.00 $2,822.00 $2,478.00 $3,305.45 $3,787.34 $4,084.49 $4,378.14 $4,647.64 $4,919.14 $5,145.61 $5,342.90 $5,507.37 $5,667.34 $5,826.57
% Revenue 104.92% 65.95% 55.72% 62.13% 65.00% 65.13% 65.43% 65.53% 65.83% 65.83% 65.83% 65.83% 65.83% 65.83%
Change in Working Capital $1,751.68 ($353.00) ($344.00) $827.45 $481.89 $297.15 $293.65 $269.50 $271.50 $226.47 $197.29 $164.48 $159.96 $159.23
Capital Expenditures 46.00 69.00 97.00 92.67 103.21 112.88 122.45 131.92 141.23 150.07 158.26 165.65 173.04 180.56
% Revenue 1.52% 1.61% 2.18% 1.74% 1.77% 1.80% 1.83% 1.86% 1.89% 1.92% 1.95% 1.98% 2.01% 2.04%
Acquisitions 67.40 0.00 0.00 26.60 29.13 31.36 33.46 35.46 37.36 39.08 40.58 41.83 43.04 44.25
% Revenue 2.23% 0.00% 0.00% .50% .50% .50% .50% .50% .50% .50% .50% .50% .50% .50%
Unlevered Free Cash Flow -1556.87 678.23 882.37 407.39 324.17 698.87 748.78 866.76 914.61 997.50 1,059.91 1,120.23 1,148.10 1,171.04
Discounted Free Cash Flow 296.80 596.27 595.32 642.17 631.46 641.76 635.45 625.85 597.72 568.13
EBITDA 359.0 601.0 1111.0 2359.8 1975.8 2289.8 2510.8 2708.3 2835.3 2938.4 3028.2 3102.3 3170.6 3237.1
EBITDA Margin 12% 14% 25% 44% 34% 37% 38% 38% 38% 38% 37% 37% 37% 37%
UOIG 13
University of Oregon Investment Group November 30, 2011
Appendix 3 – Revenue Model
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
MMORPG 1152.00 1248.00 1230.00 1516.24 1579.76 1642.95 1705.39 1766.78 1826.85 1885.31 1941.87 1996.24 2048.14 2093.20
% Growth 8.3% -1.4% 23.3% 4.2% 4.0% 3.8% 3.6% 3.4% 3.2% 3.0% 2.8% 2.6% 2.2%
% Total 29.2% 27.7% 28.5% 27.1% 26.2% 25.5% 24.9% 24.4% 24.1% 23.9% 23.9% 23.8% 23.6%
PC and other growth 99.00 164.00 325.00 414.20 478.79 550.60 605.66 654.12 699.91 741.90 778.99 810.15 834.46 859.49
% Growth 65.7% 98.2% 27.4% 15.6% 15.0% 10.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 3.0%
% Total 3.8% 7.3% 7.8% 8.2% 8.8% 9.1% 9.2% 9.4% 9.5% 9.6% 9.7% 9.7% 9.7%
Console 1294.00 2199.00 2330.00 2741.00 3095.45 3374.04 3643.96 3899.04 4132.98 4339.63 4513.21 4648.61 4788.07 4931.71
% Growth 69.9% 6.0% 17.6% 12.9% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 3.0% 3.0%
% Total 51.4% 52.4% 51.5% 53.1% 53.8% 54.5% 55.0% 55.3% 55.5% 55.6% 55.6% 55.6% 55.7%
Handheld 237.00 244.00 184.00 157.70 162.43 170.55 180.79 195.25 214.77 231.96 245.87 255.71 263.38 271.28
% Growth 3.0% -24.6% -14.3% 3.0% 5.0% 6.0% 8.0% 10.0% 8.0% 6.0% 4.0% 3.0% 3.0%
% Total 5.7% 4.1% 3.0% 2.8% 2.7% 2.7% 2.8% 2.9% 3.0% 3.0% 3.1% 3.1% 3.1%
Distribution 227.00 423.00 378.00 490.95 510.10 533.05 555.44 577.11 597.88 617.61 636.14 655.22 674.88 695.13
% Growth 86.3% -10.6% 29.9% 3.9% 4.5% 4.2% 3.9% 3.6% 3.3% 3.0% 3.0% 3.0% 3.0%
% Total 9.9% 8.5% 9.2% 8.8% 8.5% 8.3% 8.1% 8.0% 7.9% 7.8% 7.8% 7.8% 7.9%
Other* 17.00 1.00 0.00
% Growth -94.1% -100.0%
% Total 0.0% 0.0%
Total Revenue 3026.00 4279.00 4447.00 5320.09 5826.53 6271.20 6691.24 7092.29 7472.39 7816.40 8116.09 8365.94 8608.93 8850.81
% Growth 41.4% 3.9% 19.6% 9.5% 7.6% 6.7% 6.0% 5.4% 4.6% 3.8% 3.1% 2.9% 2.8%
% Total
UOIG 14
University of Oregon Investment Group November 30, 2011
Appendix 4 – Working Capital Model
Working Capital Model
($ in millions) 2008A 2009A 2010A 2011E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E 2019 E 2020 E 2021 E
Total Revenue $3,026.00 $4,279.00 $4,447.00 $5,320.09 $5,826.53 $6,271.20 $6,691.24 $7,092.29 $7,472.39 $7,816.40 $8,116.09 $8,365.94 $8,608.93 $8,850.81
Current Assets
Cash & Cash Equivalents 2958.00 2768.00 2812.00 3600.00 4292.50 4620.10 4929.55 5225.00 5505.03 5758.47 5979.26 6163.32 6342.34 6520.54
% of Revenue 98% 65% 63% 68% 74% 74% 74% 74% 74% 74% 74% 74% 74% 74%
Accounts Receivable 974.00 739.00 640.00 363.37 1074.12 1156.10 1233.53 1307.46 1377.54 1440.95 1496.20 1542.26 1587.06 1631.65
Days Sales Outstanding A/R 117.49 63.04 52.53 24.93 67.29 67.29 67.29 67.29 67.29 67.29 67.29 67.29 67.29 67.29
% of Revenue 32% 17% 14% 7% 18% 18% 18% 18% 18% 18% 18% 18% 18% 18%
Inventory 262.00 241.00 112.00 229.75 289.62 301.02 307.80 297.88 298.90 312.66 324.64 334.64 344.36 354.03
Days Inventory Outstanding 52.00 38.13 19.23 51.66 44.90 45.87 45.35 42.68 40.54 40.43 40.43 40.43 40.43 40.43
% of Revenue 8.7% 5.6% 2.5% 4.3% 5.0% 4.8% 4.6% 4.2% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%
Short-Term Investments 44.00 477.00 696.00 1041.54 601.91 647.84 691.23 732.66 771.93 807.47 838.43 864.24 889.34 914.33
% of Revenue 1.5% 11.1% 15.7% 18.0% 10.3% 10.3% 10.3% 10.3% 10.3% 10.3% 10.3% 10.3% 10.3% 10.3%
Software Development 235.00 224.00 147.00 246.14 302.98 344.92 401.47 461.00 523.07 547.15 568.13 585.62 602.62 619.56
% of Revenue 7.8% 5.2% 3.3% 4.6% 5.2% 5.5% 6.0% 6.5% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0%
Intelectual Property License 35.00 55.00 45.00 70.71 66.76 71.86 76.67 81.27 85.62 89.56 93.00 95.86 98.64 101.42
% of Revenue 1.2% 1.3% 1.0% 1.3% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1%
Deferred Income taxes, net 536.00 498.00 640.00 902.57 837.22 901.12 961.48 1019.10 1073.72 1123.15 1166.22 1202.12 1237.03 1271.79
% of Revenue 17.7% 11.6% 14.4% 17.0% 14.4% 14.4% 14.4% 14.4% 14.4% 14.4% 14.4% 14.4% 14.4% 14.4%
Intangible assets, net 14.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
% of Revenue 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Other current assets 201.00 327.00 293.00 237.96 404.44 435.31 464.46 492.30 518.69 542.56 563.37 580.71 597.58 614.37
% of Revenue 7% 8% 7% 4% 7% 7% 7% 7% 7% 7% 7% 7% 7% 7%
Total Current Assets 5259.00 5329.00 5385.00 6692.04 7869.55 8478.25 9066.19 9616.68 10154.49 10621.98 11029.23 11368.76 11698.97 12027.67
% of Revenue 174% 125% 121% 126% 135% 135% 135% 136% 136% 136% 136% 136% 136% 136%
Long Term Assets
Net PP&E Beginning 210 270 323 367 401 422 429 453 481 508
Capital Expenditures and acquisitions 113.40 69.00 97.00 119.27 108.63 120.69 131.70 142.52 153.19 163.65 173.52 182.61 190.74 198.87
Depreciation and Amortization -49 -67 -87 -109 -132 -157 -150 -154 -164 -190
Net PP&E Ending 0.0 0.0 0.0 0.0 270 323 367 401 422 429 453 481 508 516
Total Current Assets & Net PP&E 5259 5329 5385 8139 8801 9433 10018 10577 11051 11482 11850 12206 12544
% of Revenue 0 0 0 0 5% 5% 5% 6% 6% 5% 6% 6% 6% 6%
Current Liabilities
Accounts Payable 319.00 302.00 363.00 456.86 500.35 538.54 574.61 609.05 641.69 671.23 696.97 718.42 739.29 760.06
% of Revenue 11% 7% 8% 9% 9% 9% 9% 9% 9% 9% 9% 9% 9% 9%
Accrued Expense and Other Liabilities 842.00 779.00 818.00 1142.49 1251.25 1346.74 1436.95 1523.07 1604.70 1678.58 1742.93 1796.59 1848.77 1900.72
% of Revenue 28% 18% 18% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21%
Deferred Revenue 923.00 1426.00 1726.00 2074.83 2330.61 2508.48 2676.50 2836.91 2988.96 3126.56 3246.44 3346.37 3443.57 3540.32
% of Revenue 31% 33% 39% 39% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40%
Total Current Liabilities 2084.00 2507.00 2907.00 3674.19 4082.21 4393.76 4688.05 4969.04 5235.35 5476.37 5686.34 5861.39 6031.63 6201.10
% of Revenue 69% 59% 65% 69% 70% 70% 70% 70% 70% 70% 70% 70% 70% 70%
UOIG 15
University of Oregon Investment Group November 30, 2011
Appendix 5 – Discounted Cash Flows Analysis Assumptions
Discounted Free Cash Flow Assumptions
Tax Rate 32.24% Terminal Growth Rate 3.00%
Risk Free Rate 2.26% Terminal Value 27,975
Beta 0.72 PV of Terminal Value 12,648
Market Risk Premium 7.00% Sum of PV Free Cash Flows 5,603 Considerations
% Equity 100.00% Firm Value 18,250
% Debt 0.00% Total Debt 0 Current Reinvestment Rate 60.93%
Cost of Debt 0.00% Cash & Cash Equivalents 2,469 Reinvestment Rate in Perpetuity 13.65%
CAPM 7.31% Market Capitalization 15 Implied Return on Capital in Perpetuity 14.65%
WACC 7.31% Fully Diluted Shares 1,181 Terminal Value as a % of Total 64.5%
Implied Price 15.5 Implied 2013 E EBITDA Multiple 6.9x
Current Price 11.9 Implied Terminal Year Multiple 3.1x
Undervalued 30.09% Terminal Free Cash Flow Growth Rate 2%
Beta SD Weighting
5 year weekly 0.75 0.08 25.00%
5 year Monthly 0.60 0.22 0.00%
3 year weekly 0.62 0.09 25.00%
0.73
Vasicek Beta 3 Year weekly 25.00%
0.79
Vasicek Beta 5 year weekly 25.00%
0.72
Activision Blizzard Inc Beta
UOIG 16
University of Oregon Investment Group November 30, 2011
Vasicek Beta 5 Year weekly
Company Beta Weighting SD Variance
Nintendo 0.62 16.67% 0.10 0.01
Konami Corporation 0.72 16.67% 0.10 0.01
Electronic Arts 0.99 16.67% 0.09 0.01
Take Two Interactive Software, Inc 1.07 16.67% 0.14 0.02
Intuit Inc 0.70 16.67% 0.06 0.00
Microsoft 0.78 16.67% 0.06 0.00
Industry Activision Blizzard Inc
Beta 0.81 0.75
Variance 0.01 0.01
Weight 56% 44%
Vasicek Beta 0.79
Vasicek Beta 3 Year weekly
Company Beta Weighting SD Variance
Nintendo 0.53 17% 0.14 0.02
Konami Corporation 0.62 17% 0.12 0.01
Electronic Arts 1.02 17% 0.12 0.02
Take Two Interactive Software, Inc 1.12 17% 0.16 0.02
Intuit Inc 0.71 17% 0.08 0.01
Microsoft 0.84 17% 0.08 0.01
Industry Activision Blizzard Inc
Beta 0.81 0.62
Variance 0.01 0.01
Weight 62% 38%
Vasicek Beta 0.73
UOIG 17
University of Oregon Investment Group November 30, 2011
Appendix 6 –Sensitivity Analysis
Implied Price
Terminal Growth Rate
15 2.0% 2.5% 3.0% 3.5% 4.0%
0.52 18.76 20.84 23.63 27.59 33.64
Adjusted Beta
0.62 15.66 17.02 18.77 21.08 24.27
0.72 13.39 14.33 15.50 16.97 18.89
0.82 11.65 12.34 13.15 14.16 15.41
0.92 10.29 10.80 11.39 12.10 12.97
Appendix 7 – Expense Model
2008A 2009A 2010A 2011 E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E 2019 E 2020 E 2021 E
Cost of sales—product costs 1160 1432 1350 1436 1398 1380 1338 1418 1494 1563 1623 1673 1722 1770
%oftotalRev 38.33% 33.47% 30.36% 27.00% 24.00% 22.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00%
Cost of sales—MMORPG 193 212 241 213 227 238 248 255 276 297 308 318 327 336
%oftotalRev 6.38% 4.95% 5.42% 4.00% 3.90% 3.80% 3.70% 3.60% 3.70% 3.80% 3.80% 3.80% 3.80% 3.80%
Cost of sales—software royalties and amortization 267 348 338 372 442 464 490 519 546 571 593 612 629 647
%oftotalRev 8.82% 8.13% 7.60% 7.00% 7.58% 7.39% 7.32% 7.32% 7.31% 7.31% 7.31% 7.31% 7.31% 7.31%
Cost of sales—intellectual property licenses 219 315 197 160 287 314 401 355 374 391 406 418 430 443
%oftotalRev 7.24% 7.36% 4.43% 3.00% 4.93% 5.00% 6.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
Product development 592 627 642 692 699 721 870 922 971 1016 1055 1088 1119 1151
%oftotalRev 19.56% 14.65% 14.44% 13.00% 12.00% 11.50% 13.00% 13.00% 13.00% 13.00% 13.00% 13.00% 13.00% 13.00%
Sales and marketing 464 544 520 585 717 763 825 905 965 1029 1092 1144 1199 1256
%oftotalRev 15.33% 12.71% 11.69% 11.00% 12.30% 12.17% 12.32% 12.76% 12.92% 13.17% 13.45% 13.68% 13.93% 14.19%
General and administrative 271 395 364 426 437 455 485 514 542 567 588 607 624 642
%oftotalRev 8.96% 9.23% 8.19% 8.00% 7.50% 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% 7.25%
Impairment of intangible assets 0 409 326 300 328 353 377 399 421 440 457 471 485 498
%oftotalRev 0.00% 9.56% 7.33% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63% 5.63%
Restructuring 93 23 0 27 15 16 17 18 19 20 20 21 22 22
%oftotalRev 3.07% .54% 0.00% .50% .25% .25% .25% .25% .25% .25% .25% .25% .25% .25%
Total expenses 3259 4305 3978 4210 4550 4703 5050 5306 5609 5894 6143 6351 6558 6764
% of Revenue 107.70% 100.61% 89.45% 79.13% 78.09% 74.99% 75.48% 74.81% 75.06% 75.41% 75.69% 75.92% 76.17% 76.43%
UOIG 18
University of Oregon Investment Group November 30, 2011
Appendix 8 – Sources
SEC Filings 10-k and 10-Q
Sec.gov
Company Investor Relations page
Earnings call
IBIS World
Factset
Reuters
finance.yahoo.com
Gamespy.com
Activision.com
ActivisionBlizzard.com
Blizzard.com
UOIG 19